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Sunday, February 19, 2012

ECB the largest creditor of Greece? No, it's the Deutsche Bundesbank!

There has been much discussion about the ECB's being Greece's largest creditor through its holdings of Greek sovereign bonds. That may well be true but the largest individual creditor of Greece as a country is the Deutsche Bundesbank! The Bundesbank has allegedly (there is never official confirmation of such figures) about 100 BN EUR Target-2 claims against the Greek banking sector.

These Target-2 claims of the Bundesbank are actually claims against the ECB but if Greece exited the Eurozone, the ECB wouldn't collect on their claims against the Greek banking sector and neither would the Bundesbank collect from the ECB.

De jure, the Bundesbank is only liable for about 27% of that amount; the other 73% would have to come from other Central Banks. That will be fun to watch when the Central Bank of, say, Finland (which may not have lent anything to the Greek banking sector) may have to come up with money because the Bundesbank has lent too much!

If Greece exited the Eurozone, the Bundesbank is likely to lose much of the 100 BN EUR. If the Eurozone breaks apart, it loses all of it (plus another 400 BN EUR of claims which it has to other PIIGS banking systems).

If that isn't a good motivation to keep the Eurozone alive, then I don't know what is...

I am also very worried about this state of affairs. It means that the ECB or whoever have the Bundestag and German politicians precisely where they want them. If you think of what you said about Goldman Sachs leading the herd ... this is precisely what the ECB has done here.

The ECB Payments System (TARGET) was conceived, designed and built by the EMU national central banks, principally the German Bundesbank the French Banque de France in the mid '90's.

TARGET2 is a computer system that went into operation in about 2008, but it implements the same business system architecture and rules as the original TARGET system. The confusion arises because the consequences of a flawed business architecture only become apparent after the sub-prime fiasco and that coincided with the implementation of the TARGET2 computer system.

Initially a couple of people blamed the computer system, but Prof Sinn and others soon squashed that theory. But the name stuck and is still used to create the impression that something fundamental went wrong with the ECB in 2007/8; the problem was always there - just that it failed to show up in the benign economic climate that existed prior to 2007.

The fault lies in the business architecture that was created in the 1990's, it fails to acknowledge & deal with the inherent imbalances between Eurozone member states. The responsibility for this defect lies squarely with the 1990's national central bank Chairmen and European politicians.

The principle individuals at the time were Prof Hans Tietmeyer at the Bundesbank, Jean-Claude Trichet at the Banque de France, German Chancellor Kohl, French President Chirac and EU Commission Presidents Delors and Santer.

Have Goldman Sachs and others exploited the flaws in the design of the EMU, probably. In this respect have they acted unlawfully - probably not. Are they responsible for the flaws in the design of the EMU - almost certainly not.

Pointing fingers at 'the usual suspects' only serves to let those actually responsible off the hook.

My approach to Target-2 is not sophisticated (because it's a bit to demanding for my 63-year old brain...). It's more based on common sense and cash flows.

Take California. Never when the state of California runs out of cash does the Californian banking system automatically get into trouble. Wells Fargo may be totally unaffected by the state's bankruptcy if it has no state bonds in its portfolio. If it has half the balance sheet full of state bonds, it will be in terrible trouble but that would also be the case if it were headquartered in, say, Boston.

When the state of Greece gets into trouble, the entire country (above all the banking sector) goes down with it. That's because Greece is viewed (and with its own jurisdiction it has to be viewed that way) as country risk whereas there is no such thing as country risk with California. However, if there were a huge earthquake in California, things might be viewed differently.

The banking sectors of the PIIGS countries would not have Target-2 liabilities if the private banks which had funded them before had not withdrawn their funding. Take this example: Deutsche got cold feet in early 2009 and called back 100 MEUR short-term lines from Greek banks. What Deutsche got back turned into an increase of Target-2 liabilities on the part of Greek banks. Since no one is funding the Greek banking sector voluntarily now, all its funding requirements have to be settled via the ECB. Thus, the ECB financed Greece's current account deficit (in other words: Greece's standard of living) and the capital flight. This is what I object to because it cannot be the mission of the ECB to finance those two purposes. After all, the ECB is tax payers' money and to send tax payers' money to Greece so that wealthy Greeks can send their money to, say, Switzerland is hard to explain to tax payers...

[rant]I have tried three times to post a comment, it is perhaps the one thing I find impossible about Google - it does not do communication or ease of use. [end rant]

Tigger: a business model for the 1990s was fine in the 1990s. In the business I am in, a business model suitable for 2008 is way out of date. The models that are effective now are from the last half of 2010: and it goes for finance too. The dynamics have changed - and the crash only showed up that fact.

What is more, the guys from the Bundesbank should have been on their toes; it is the first lesson in marketing. Keep an eye on things, there are tell-tales that will show if things are going to take a lurch. That they have in Target2 should be no surprise at all.

"Pointing fingers at 'the usual suspects' only serves to let those actually responsible off the hook." No, it does not. Those who took the decisions took them. That they were mollycoddled by those who can manipulate emotions to their own ends does not mean that those manipulated are not guilty of the crime. The point is that those manipulating are doubly so. These people are skilled in making their manipulations seem casual and natural, the result of some accident of nature. I showed you that link (now dead, sadly*) about how you could tell if the markets were going up or down using exponential metrics - take this further and you can see that markets can indeed be tipped with very little effort.

(*I should have realized it and copied it to my computer in case).

Herr Kastner

your common sense in all this turmoil is most comforting. For doubly serious people like Tigger (above) who have acid incisiveness or those erratic creatures likely to fly off at tangents (me), you are a useful and sensible anchor. Your wealth of experience keeps the both of us in balance.

I am still troubled about this business of lending yet more money simply to pay for rich people to take their money out of Greek banks. Those banks are private institutions. They are there to make a profit, not render a service: I learned that lesson the hard way.

In calling back the 100 MEUR Deutsche was acting prudently in the interests of its shareholders. The fact that this created Target-2 liabilities in the Eurozone central banks is a function of what I call the the EuroZone Banking Business Architecture (EZ-BBA).

The ECB's choices are constrained by the EZ-BBA, I don't think it can change it of its own volition, my understanding is that the essentials of the EZ-BBA are contained in EU treaties and directives etc.

IMO it's unreasonable to criticise the ECB for following externally mandated bookkeeping procedures; without at least suggesting what lawful and available alternatives it might have followed.

If they had a viable alternative I'm sure the 17 national central banks governors would have told them (and us) about it. AFAIK Weber, Weidmann and Stark haven't offered any alternative to the manner in which Target-2 liabilities should be processed, even though two of that trio have been very critical of the ECB on other issues such as the SMP. When questioned on Target-2, Weidmann was quite sanguine on the issue, probably because he sees no viable alternative.

Sinn refers to Target2 as a trap. but it wasn't set by the ECB, it was set by the people who created the ECB, in other words its embedded in the ECB's DNA. But I don't think it was a deliberate trap, those responsible really wanted believe a monetary union would lift all boats to the status of ocean liners - they were right, but they got Titanic's instead of Queen Mary's.

Please bear in mind the following practical necessity: one can't have systems run the show; in the final analysis it is people and decision-makers who have to assume responsibility.

The run on Greece started some time in late 2008. It began very slowly and accelerated by the end of 2009. At the latest by the end of 2009, it was clear that there was a run on the country and once there is a run on a country of the size and the vulnerabilities of Greece, one knows that it cannot be stopped through normal measures.

That is the point where decision-makers would have had to assume responsibility: no more funding of a run; instead prompting borrower/creditors to sit down and negotiate a rescheduling amonst themselves (without the EU). After that, a deal with the EU for Fresh Money. It's been done uncountable times before. Only the EU-elites didn't know that.

Perhaps the Greek government could have stopped the run on the Greek banks, but I doubt it. As things stand it would have needed the agreement of up to 27 governments for the EU to intervene to stop the run. The Austerity Agreement and the 2nd Greek bailout are two recent examples of how difficult negotiations can be within the EU.

If the European Constitution had been implemented in 2004 then the elected President of the European Union may have had the authority to make an 'executive order'. Perhaps that was the safety valve the 'architects' envisaged, but when it was rejected no one had the courage to say "we have a problem", or the elites chose to ignore them, besides the Eurozone was up and running and appeared to be working OK.

Only the ECB, and no one else, could have stopped the run. How? By declaring that Greece did not have enough eligible collateral for further ECB funding. No EU approval equired; just the adherence to then ECB policies. Instead, they gradually deceased the benchmark for eligible collateral.